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Friday, 18 March 2016

Negative gearing set to stay

"Oops!"

The Labor Party's Opposition Leader Bill Shorten and Shadow Treasurer Chris Bowen had pledged to limit negative gearing to new properties only from 1 July 2017 in order to save the federal budget a highly questionable $32.1 billion over a decade.

This always sounded suspect based upon my day-to-day experience in the market given that the overwhelming majority of property investors are only making at worst moderate net rental losses these days.

Yes, investors have been considerably more active recently due to prevailing low interest rates, but remember the ratio of stock versus flow, while new investors have been generally able to borrow money at around just 4 per cent, or somewhere close to it.

Unfortunately as I expected it transpires that the ALP have botched their numbers, and Labor will accordingly cop a good deal of heat on this point from the Coalition.

Net rental losses halved

The latest Australian Taxation Office (ATO) Taxation Statistics to 2013-14 show that the potential budget impact of negative gearing to taxpayers has crumbled by well over 50 per cent in only two years (and by considerably more from the peak), and of course there will be more declines to come for at least the next two tax years as well.

It is no shock to me to discover that net rental deductions have fallen by more than half in the two tax years to 2013-14, from $7.9 billion to just $3.7 billion.

And recall that the cash rate has been cut several times further since 1 July 2013, from 2.75 per to only 2 per cent, so there are yet further declines to net rental losses in the post.

The latest statistics for financial year 2013-14 show that just under 1 million or exactly 60 per cent of those claiming net rental losses have a taxable income of less than $80,000 (thereby paying tax at a highest marginal rate of only 32.5 per cent or lower), while only 133,307 or 8 per cent of those claiming are paying tax at the highest marginal rate.

It is true to a point that middle aged and slightly older Aussies tend to negatively gear property around their peak earning years. This rings true from my experience and the experiences of my peers - none of us owned rental properties as students, or indeed for some time after that as we paid off student debts and saved initial deposits, but plenty do now we are in our late thirties.

Given that taxpayers across all taxable income brackets use negative gearing, after tax-effecting net rental losses of only $3.7 billion in financial year 2014 it is clear that as things stand such a move to limit negative gearing to new dwellings prospectively could only save a fraction of the amount claimed from the federal budget.

Remember that Labor is notproposing to scrap negative gearing, rather to grandfather existing arrangements and limit negative gearing to new dwellings.

With a record 776,672 earning a profit for their rental properities, the total cost of negatively geared properties only fell by 12.5 per cent to a four year low of $10.9 billion.

And given that negative gearing losses are carried forward and taxes levied at a future date - or upon eventual sale in event of a capital gain - net rental losses are a timing difference only and the ALP projections are exposed as too optimistic.

Further declines in the post
Realistically, then, the projected $32.1 billion of savings could only feasibly come from cranking up the rate of capital gains tax, itself a crappy tax - an inefficient tax insincerely marketed as a "discount", although in the case of property it is actually levied on top of fairly vicious stamp duties as well as rates/land taxes etc.

Total capital gains reported by taxpayaers increased by 37 per cent to $34.4 billion, largely thanks to fewer loss making transacions as the financial crisis fades into the rear-view mirror.

It is worth noting in passing that moves to restrict property investor activity and therefore lending would also result in lost levies from stamp duties and reduced company taxes on bank earnings, as well as putting downward pressure on superannuation balances via lower share prices.

If this sounds harsh on Labor, recall that they were actually in government until 2013, so where were the sweeping policy changes then?

Ironically, the ALP was in power for a six year stretch when scrapping negative gearing might actually have made a material difference to the budget, but alas that particular ship has now well and truly sailed.

Futures markets are pricing in a further 25 basis points cut to the cash rate by November 2016, suggesting that the ATO aggeregated statistics for net rental deductions could continue declining for at least another three tax years to come.

A potent combination of the existing negative gearing rules and low interest rates have encouraged record dwelling investment - and in turn a surge residential construction jobs - and at the same time have done an an sterling job of keeping capital city rents down as new supply comes online apace, encouraged by strong aggregate demand for property and an uplift in prices.

And all of this is before the potential distortions of encouraging investors to speculate on considerably riskier new properties are even touched upon, let alone the concerning impact of increased public housing costs on the budget.

On the back of these slim pickings, and given that PM Turnbull has already batted changes to the capital gains tax to the fence, there is Buckley's chance of the Coalition proposing a similar move to the ALP in Opposition.

Presumably this is for similar reasons that Labor took no such action when they weren't in Opposition - pollies actively deflating a housing market in the midst of a once-in-a-century terms of trade and resources investment bust? It seems like a remote possibility to me, but you can choose to believe whatever you want.

The wrap

All of this has been well known about for some time, of course: scrapping negative gearing was never going to be much of a boon for the budget.

If negative gearing is going to be binned then it should be so on intergenerational grounds or because it represents iniquitous tax legislation, not based upon bogus claims of "billions" to be saved in the budget.

Finally for today, spare a thought for the taxation figures above, the line items of which I have charted simply as the ATO present them, for they're doubtless set to once again be tortured mercilessly come Monday morning.